Software Sector Sees Reliable Revenue Accounting on Horizon

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By Steve Burkholder

Auditors and analysts in the computer software sector see current safeguards against deficient financial reporting and a stricter auditing environment preventing a repeat of the 1990s’ bad old days of errant reporting of revenue.

On the eve of the advent of major new revenue rules—dealing with what is widely viewed as the most important line in the financial statements—senior corporate accountants such as IBM Corporation’s Gregg Nelson see a changed financial reporting landscape.

The terrain now includes more than a decade of experience in using internal controls over financial reporting. This contributes to an accounting and auditing structure that likely would head off irregular accounting, including the rampant premature booking of revenue that preceded the bursting of the dot-com bubble in 2000. The debacle led to huge losses in investments and widespread bankruptcies.

“I think the environment is much different today,” Nelson, IBM’s vice president for accounting policy and financial reporting, said in a recent webinar on the revenue reporting standard, ASC 606, held by the Financial Accounting Standards Board.

“And in recent years we’ve not seen the problems in the software industry of any significant magnitude,” Nelson said. “I think this is a key indicator of the improved environmental landscape that we have.

“As a result, regulators and standard setters can and have issued more principles-based guidance instead of the prior, very rules-based guidance,” he said, citing FASB’s new, single source of revenue guidance. The revenue standard, which becomes effective for public companies in January, replaces scores of industry-specific rules.

More Robust Checks

Nelson and another presenter in the June 13 FASB webinar, Stacy Harrington, Microsoft’s senior director for revenue assurance, agreed that a more robust accounting and auditing environment has taken hold in the software sector. That includes a tightening of rules that prevented up-front reporting of revenue—and which many observers of accounting rulemaking believe went too far in deferring revenue.

The more effective reins on errant reporting are seen as mitigating the risk of companies taking advantage of the leeway in judgments and estimates that are inherent in the new, much less prescriptive standard on revenue.

Management accountants such as Harrington see the new rules—which carry prospects of quicker booking of revenue for many software companies—leading to financial statements that better reflect the economics of individual transactions. In the software industry, the customer contracts include sales, upgrades, and software as a service. In software as a service, a third-party company offers and hosts software applications at a central, on-line location.

‘Need for Framework, Not Rules’

Harrington said she fully supports the more principles-based standards, which she believes will accommodate rapid technological change and accompanying shifts in business offerings.

“We do really need a framework instead of just rules,” said the Microsoft accountant. “We can only provide rules for the fact patterns we’re aware of today.”

FASB, the American institute of CPAs and other guidance-writers have carried out “a lot of due diligence” to test the accounting, said Harrington, and “to really make sure that we’re not boxing in” companies and providing a set of rules based simply on today’s fact patterns.

The FASB rules become effective for public companies in about six months. More and more surveys signal that many companies appear to be behind in their preparation for what could be a big shift in accounting.

Jack Ciesielski, an accountant-analyst and publisher of Analyst’s Accounting Observer, told Bloomberg BNA June 14 that he tends to agree with Nelson’s reading on the general effectiveness of safeguards in the financial reporting picture that has changed markedly since 2000.

A landmark event was passage of the Sarbanes-Oxley Corporate and Accounting Reform Law of 2002, in the months after the collapse of Enron Inc. and WorldCom. SOX set up a new audit regulatory body, the Public Company Accounting Oversight Board, and requirements for internal control over financial reporting. Such internal controls have to be cleared by a company’s independent auditor.

Software and tech companies saw that they could “drive a truck” through the old rules and “recognized everything up front,” Ciesielski said.

Cautionary Note on Smaller Companies

Ciesielski, chief of investment advisers R.G. Associates, Inc., in Baltimore, said a view circulating in accounting rulemaking circles that smaller public companies—which are mostly audited by smaller accounting firms—account for a lot of recent restatements of company’s financial filings as “a valid hypothesis.”

Ciesielski and another veteran CPA-analyst, who requested anonymity, suggested June 14 that smaller public companies, including in the software sector, might face a more difficult time in ensuring proper reporting under the new accounting rules than the IBMs and Microsofts of the world. The smaller companies don’t have the resources and level of internal controls on financial reporting that the larger enterprises have.

To contact the reporter on this story: Steve Burkholder in Norwalk, Conn. at sburkholder@bna.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bna.com

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